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Right Fiscal Policies Can Help Fight Income Inequality

Street vendors in Udaipur, India: countries need to reduce debts and promote fair income distribution (photo: Corbis)

TAXES & INEQUALITY

Right Fiscal Policies Can Help Fight Income Inequality

IMF Survey online

December 16, 2011

  • Reducing government debts and deficits can be done equitably
  • The poor suffer more during tough economic times
  • Low-income countries have options to boost incomes, promote fairness

Taxes and income transfer policies can help reduce income inequality while also raising revenues, according to the International Monetary Fund.

Speaking at a global conference on tax and inequality held in New Delhi, India, senior officials from the IMF said many countries face a double challenge: to ensure fiscal sustainability and reduce inequality.

“These two goals are not inconsistent, although they may end up being so if fiscal adjustment is not carefully planned and the wrong instruments are used,” said Carlo Cottarelli, head of the IMF’s Fiscal Affairs department.

Governments around the world face a dilemma—how to reduce debts and deficits and support development, growth, and employment as anxious financial markets rattle the global economic recovery.

The IMF has focused on issues of inequality and poverty for many years, and the issues are once again front and center as countries struggle to recover from the global economic crisis.

“We see concerns about the link between taxation and social justice almost everywhere we look,” Min Zhu, a Deputy Managing Director at the IMF, told the assembled conference delegates from over 80 countries. “We see them in the Occupy movement; in the Arab spring; in the debates on the expiration or not of the Bush tax cuts in the U.S., on how to distribute the pain of fiscal consolidation in Europe; and in the needs of many lower income countries to overcome resistance from elites to establish tax systems with the legitimacy and revenue productivity needed for their sustainable development.”

Poor suffer more

Ensuring economic stability is critical as the poor suffer more than the rich during times of economic crises. High rates of inflation typically hurt the poor disproportionately, as inflation erodes their real incomes, the IMF said.

Also, the poor lack the extra reserves of funds for a rainy day, which would allow them to spend in tough economic times. And periods of economic instability are typically accompanied by rising unemployment and long-term unemployment that exerts downward pressure on the real incomes of poor and low skilled households.

The right kind of fiscal tools

Countries should ensure that the tools to reduce government debts and deficits will promote equitable income distribution.

“Fiscal consolidation will be painful in many countries, but it does not have to be unfair,” Min Zhu said in the conference.

Tax and spending sides of the equation should be viewed as a whole. Some revenue sources, such as the value-added-tax, are not necessarily redistributive themselves, but can be used to effectively and efficiently to pay for spending to benefit the poor.

One of the most inequitable aspects of tax systems comes from tax evasion and avoidance regardless of the type of tax in question.

Income inequality can be exacerbated where the wealthy have greater opportunities for, and benefits from, tax evasion. One example of this is income on investments.

There are a number of potential revenue sources that can contribute to both fiscal sustainability and improved equality, including in low-income countries, delegates were told:

• Personal income taxes — weaker tax administrations in many low income countries mean that advanced economies, in practice, are better able to utilize the tax in general, and to rely on it for redistributive effects through progressive rates. Empirical evidence suggests that fears that progressive income taxes will cause labor migration or reduction in labor effort are frequently overstated.

• Taxation of natural resources offers an efficient and equitable source of revenues. The revenue potential from natural resources in Africa has grown significantly in the past 20 years, as new reserves of oil and gas have been discovered.

• Property taxes — are another revenue source that can be both efficient and equitable. Yet property taxes are under exploited in most countries. Low income countries have room to increase revenues from this source as their income rises. The IMF‘s technical assistance is helping developing countries introduce or improve property taxes.


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